The Deflation Monster Has Arrived

As we’ve been warning for quite a while (too long for my taste): the world’s grand experiment with debt has come to an end. And it’s now unraveling.

Just in the two weeks since the start of 2016, the US equity markets are down almost 10%. Their worst start to the year in history. Many other markets across the world are suffering worse.

If you watched stock prices today, you likely had flashbacks to the financial crisis of 2008. At one point the Dow was down over 500 points, the S&P cracked below key support at 1,900, and the price of oil dropped below $30/barrel. Scared investors are wondering: What the heck is happening? Many are also fearfully asking: Are we re-entering another crisis?

Sadly, we think so. While there may be a market rescue that provide some relief in the near term, looking at the next few years, we will experience this as a time of unprecedented financial market turmoil, political upheaval and social unrest. The losses will be staggering. Markets are going to crash, wealth will be transferred from the unwary to the well-connected, and life for most people will get harder as measured against the recent past.

It’s nothing personal; it’s just math. This is simply the way things go when a prolonged series of very bad decisions have been made. Not by you or me, mind you. Most of the bad decisions that will haunt our future were made by the Federal Reserve in its ridiculous attempts to sustain the unsustainable.

The Cost Of Bad Decisions

In spiritual terms, it is said that everything happens for a reason. When it comes to the Fed, however, I’m afraid that a less inspiring saying applies:

Yes, it’s easy to pick on the Fed now that it’s obvious that they’ve failed to bring prosperity to anyone but their inside coterie of rich friends and big client banks. But I’ve been pointing out the Fed’s grotesque failures for a very long time. Again, too long for my tastes.

I rather pointlessly wish that the central banks of the world had been reined in by the public before the crash of 2008. However the seeds of their folly were sown long before then:

Note the pattern in the above monthly chart of the S&P 500. A relatively minor market slump in 1994 was treated by the then Greenspan Fed with an astonishing burst of new money creation -- via its ‘sweeps” program response, which effectively eliminated reserve requirements for banks .That misguided policy created the first so-called Tech Bubble, which burst in 2000.

The next move by the Fed was to drop rates to 1%, which gave us the Housing Bubble. That was a much worse and more destructive event than the bubble that preceded it. And it burst in 2008.

Then the Fed (under Bernanke this time) dropped rates to 0%. The rest of the world’s central banks followed in lockstep (some going even further, into negative territory, as in Europe’s case). This has led to a gigantic, interconnected set of bubbles across equities, bonds and real estate -- virtually everywhere across the globe.

So the Fed's pattern here was: fixing a small problem with a bad decision, which lead to an even larger problem addressed by an even worse decision, resulting in an even larger set of problems that are now in the process of deflating/bursting. Three sets of increasingly bad decisions in a row.

The amplitude and frequency of the bubbles and crashes are both increasing. As is the size and scope of the destruction.

The Even Larger Backdrop

The even larger backdrop to all of this is that the developed world, and recently China, have been stoking growth with debt, and have been doing so for a very long time.

Using the US as a proxy for other countries, this is what the lunacy looks like:

As practically everybody can quickly work out, increasing your debts at 2x the rate of your income eventually puts you in the poor house. As I said, it’s nothing personal; it’s just math.

But somehow, this math escaped the Fed’s researchers and policy makers as a problem. Well, turns out it is. And it’s now knocking loudly on the world’s door. The deflation monster has arrived.

The only possible way to rationalize such an increase in debt is to convince oneself that economic growth will come roaring back, and make it all okay. But the world is now ten years into an era of structurally weak GDP and there are no signs that high growth is coming back any time soon, if ever.

So the entire edifice of debt-funded growth is now being called into question -- at least by those who are paying attention or who aren't hopelessly blinkered by a belief system rooted in the high net energy growth paradigms of the past.

At any rate, I started the chart in 1970 because it was in 1971 that the US broke the dollar’s linkage to gold. The rest of the world complained for a bit at the time, but politicians everywhere quickly realized that the loss of the golden tether also allowed them to spend with wild abandon and rack up huge deficits. So it was wildly popular.

As long as everybody played along, this game of borrowing and then borrowing some more was fun. In one of the greatest circular backrubs of all time, the central banks and banking systems of the developed world all bought each other’s debt, pretending as if it all made sense somehow:

The above charts show how hopelessly entangled the worldwide web of debt has become. Yes, it's all made possible by the delusion that somehow being owed money by an insolvent entity will endlessly prevent your own insolvency from being revealed. How much longer can that delusion last?

All of this is really just the terminal sign of a major credit bubble -- a credit era, if you will -- drawing to a close.

I will once again rely upon this quote by Ludwig Von Mises because apparently its message has not yet sunk in everywhere it should have:

“ There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

~ Ludwig Von Mises

Well, the central banks of the world could not bring themselves to voluntarily end the credit expansion – that would have taken real courage.

So now we are facing something far worse.

Why The Next Crisis Will Be Worse Than 2008

I’m not just calling for another run of the mill bear market for equities, but for the unwinding of the largest and most ill-conceived credit bubble in all of history. Equities are a side story to a larger one.

It’s global and it’s huge. This deflationary monster has no equal in all of history, so there’s not a lot of history to guide us here.

At Peak Prosperity we favor the model that predicts ‘first the deflation, then the inflation’ or the "Ka-Poom! Theory" as Erik Janszen at iTulip described it. While it may seem that we are many years away from runaway inflation (and some are doubting it will or ever could arrive again), here’s how that will probably unfold.

Faced with the prospect of watching the entire financial world burn to the figurative ground (if not literal in some locations), or doing something, the central banks will opt for doing something.

Given that their efforts have not yielded the desired or necessary results, what can they realistically do that they haven't already?

The next thing is to give money to Main Street.

That is, give money to the people instead of the banks. Obviously puffing up bank balance sheets and income statements has only made the banks richer. Nobody else besides a very tiny and already wealthy minority has really benefited. Believe it or not, the central banks are already considering shifting the money spigot towards the public.

You might receive a credit to your bank account courtesy of the Fed. Or you might receive a tax rebate for last year. Maybe even a tax holiday for this year, with the central bank monetizing the resulting federal deficits.

Either way, money will be printed out of thin air and given to you. That’s what’s coming next. Possibly after a failed attempt at demanding negative interest rates from the banks. But coming it is.

This "helicopter money" spree will juice the system one last time, stoking the flames of inflation. And while the central banks assume they can control what happens next, I think they cannot.

Once people lose faith in their currency all bets are off. The smart people will be those who take their fresh central bank money and spend it before the next guy.

In Part 2: Why This Next Crisis Will Be Worse Than 2008 we look at what is most likely to happen next, how bad things could potentially get, and what steps each of us can and should be taking now -- in advance of the approaching rout -- to position ourselves for safety (and for prosperity, too)

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45 Comments

I am in such a mindset of doing what is best for the homestead and family that many times I tune out of the regular news cycle. Maybe its bad, but you can only obsess about things you can't control for so long, and then at some point come to the realization that you work on the things you can influence. So, naturally, PP provides the needed update.

Perhaps this is something available to the paying members, but there was something that was REALLY helpful a couple of months ago. I don't think Chris does it much, but he provided his direct analysis of how badly the big banks and other financial institutions took a bath during the waves that hit back in October. He compared it to their performance when 2008 started to unfold, and I found it very enlightening. Seeing the losses on charts and graphs as a percentage of the damage being done to everyone really put things in perspective. Would like to see something like that again if possible.

Even more than gold, silver sure looks like the sweet spot when you study that graphic (physical silver, that is).Tiny market - would literally explode upward if even a minuscule amount of "wealth" was moved into it from other types. No counterparty risk. Has growing industrial demand to keep it going until the herd wakes up. Peak cheap silver has already happened due to extremely low ore grades. Price-wise the gold-silver ratio is about 75:1, but they are being mined out of the ground at less than 15:1. A monumental adjustment is inevitable.

It appears those debt circles are obsolete? China is not listed but holds ~$1.2 Trillion of US debt. And Japan holds ~1.25 Trillion of US debt now.

The BBC visualization only covers US, Europe and Japan. China was not part of that excellent visualization. Nor was the rest of Asia, or Australia, etc.

Plus I only captured four of the countries invovled...there are more if you follow the link.

However, it is certainly true that the amounts have changed since this was created...on that basis it is obsolete if you are seeking accuracy...but if you are seeking to simply see how ridiculous the whole situation is I think it's still plenty relevant and useful.

Derivatives is a fancy word for a bet if I have any grasp on the subject at all. Someone has insured someone else against business losses.

It would appear to me that someone has been taking insurance premiums under false pretense. They have absolutely no intention of paying out. I always wondered how you city slickers made money.

But then again, Catherine A. Fitts has said that the wealth of the world has been drained off for a second parallel economy. Rumour has it that it is a secret space program.

My discussion with the uber lawyer Karen Hudes reveal that Catherine A Fitts is, in her opinion, a Vatican shill. (I have asked permission to reveal this fact.) My understanding of KH's position is that the money represented by the derivatives market is held as gold in the Philippines.

(I asked Karen to debate Catherine)

I'm not going there. Fitts is a Vatican shill. She was involved in this book, written by Vatican agents:

ZeroHedge is reporting that the dallas Fed has secretely met with Texas banks regarding bad energy loans.It appears that Wells Fargo is also involved in the jackpot...If anyone ever read the Jesse Eisenger piece In the Atlantic concerning Wells derivatives,you cant not know...

One of the things I admire about Catherine Austin Fitts is that she admits to the things she knows she is unsure of. Thus her generic name "Mr. Global" for whatever behind-the-scenes world power may exist. When I heard Hudes argue her case over at Red Ice Radio back in 2014, she let us know she is absolutely convinced that coneheads rule the world via the Vatican. But she gave absolutely no convincing proof. She could only remind us of the type of hats they wear.

If you read the Zerohedge piece the fed has asked the banks not to write off the the shale losses.Why? because it will affect tier one capital.That is when regulators get involved and the fed gets involved.The fact that the fed is now involved is serious.The shorts will probably obliterate the banks involved and the public will not have it.Who do we know is involved? Wells,Citi,probably UBS and many more.The fact that the Dallas Fed hasnt responded to Zerohedge is very,very scary.My guess is the 2 sources are women.They always come forward when it hits the fan!!!!

It appears those debt circles are obsolete? China is not listed but holds ~$1.2 Trillion of US debt. And Japan holds ~1.25 Trillion of US debt now.

Also, where are the central banks in those charts? Isn't that what the QE and various other acronyms are all about? Aren't they now buying like half the government debts? Are any western governments defaulting on their debt? No. Why is there any reason the governments would default on their debts even if 100% of their funding came from CB's? It's pretty easy for the banks to keep things together -- just loosen the market support a bit and let deflation strengthen the dollar, and then hit the print button, voila, negligible inflation and free money. Replace dollars up the Exter's Pyramid with dollars lower down. Steal wealth from the masses via deflation and bring it back into existence in their own accounts with the printing presses.

I think we have all underestimated the sophistication of the market manipulation activities over the last few years. Even in 2008 the crash was allowed to drop 777.7 points -- I don't chalk that up to chance any more than Thomas Anderson's passport in The Matrix just happening to expire on 9/11/01 by chance. Clearly the banks were in full control even back then, despite them telling us that we were mere hours away from a total global collapse -- since when does anyone here believe anything the banks say?

Are we in a deflationary period? Obviously. Is it out of control? I doubt it. I'm sure the CB's have the electronic printing press hooked directly up to their derivative accounts and are milking the ride down for all it's worth, making billions, who knows maybe trillions on levered derivative bets, with the added bonus of an appreciating dollar for their ill gotten winnings.

In terms of how the financial system works, we are not smarter than the banks. They can and do read the internet just like everyone else. Beyond this, they have access to insider information we could only dream of. Does anyone honestly believe they don't know what's going on? No one could have kept this scheme together this long if they were incompetent buffoons. Nomi Prins was talking to Fed officials who gave the impression that they are bumbling idiots not knowing what they are doing? Well do lower Fed officials make any big decisions? Aren't Fed officials known to be puppet-stringed actors? Is it possible that the Fed officials she was talking to actually know who she is and put on the face that they wanted her to see?

Will the system soon collapse? Who knows, we've all seen that predicting the future in this game is near impossible but based on the last few years I'm guessing we've still got a ways to go. I think we'll see the stock markets go back up before the crash. I think we can expect to see the crash when we see activities and plans form the central banks seriously change tone, and by this I mean we won't see discussion of their plans for the next few months over meaningless nonsense like rate hikes or negative rates, that kind of waffling. When we are near the end, I believe that kind of talk will end.

It would appear that Capensis would rather I not ask rude questions, and has deleted my piece.

I am amused. It was obliquely pertinent to to question of where the money went.

Still, what a pity we have to make allowances for peoples feelings. I am sure that Queen's Council would have no time for such niceties if we ever did find out where it went and bring the perps to stand in the dock.

*Sigh* I'm such a romantic old fool and hold to such old fashioned ideas such as the rule of law and the dispensation of justice.

If you read the Zerohedge piece the fed has asked the banks not to write off the the shale losses.Why? because it will affect tier one capital.That is when regulators get involved and the fed gets involved.The fact that the fed is now involved is serious.The shorts will probably obliterate the banks involved and the public will not have it.Who do we know is involved? Wells,Citi,probably UBS and many more.The fact that the Dallas Fed hasnt responded to Zerohedge is very,very scary.My guess is the 2 sources are women.They always come forward when it hits the fan!!!!

Suspending Mark to Market for shale debt??? So now the FED is micro managing the banks...this is going to get REALLY bad!

[EDIT]

Just saw the Zerohedge headline...they did it!

Next will be auto and students loans, ban mark to market problem fixed.

I don't see how this market downturn will be worse than 2008, since the entire mechanism for this upturn in the first place was due to injection of large quantities of base money into the banks by the Fed. Base money doesn't just disappear. This isn't the unraveling of a private credit bubble a la 2008, since at the end of the day, the banks still have the built up stores of base money on its balance sheets. I don't see the Dow going below 14k to be honest.

Stock markets across the Middle East saw more than £27bn wiped off their value as the lifting of economic sanctions against Iran threatened to unleash a fresh wave of oil onto global markets that are already drowning in excess supply.

All seven stock markets in the Gulf states tumbled as panic gripped traders. London shares are now braced for a second wave of crisis to hit when they open on Monday morning after contagion from China sent the FTSE 100 to its worst start in history last week.

Dubai's DFM General Index closed down 4.65pc to 2,684.9, while Saudi Arabia's Tadawul All Share Index, the largest Arab market, collapsed by 7pc intraday, before recovering to end down 5.44pc at 5,520.41, its lowest level in almost five years.

It would still have to be issued first as Bonds which are just more debt

The amount needed to goose the economy would be truly staggering and the banks would never permit it because

A very significant amount of it would be used to pay down existing debt, transferring personal debt to the state, usurping the privileges of the financial sector.

The distribution would be a political nightmare. If you want a real shitfight, just try suggesting that the "worthless" unemployed, welfare queens, blacks, immigrants, Muslims, women, you name it, get as much or more than the middle aged white guys.

It would still have to be issued first as Bonds which are just more debt

The amount needed to goose the economy would be truly staggering and the banks would never permit it because

A very significant amount of it would be used to pay down existing debt, transferring personal debt to the state, usurping the privileges of the financial sector.

The distribution would be a political nightmare. If you want a real shitfight, just try suggesting that the "worthless" unemployed, welfare queens, blacks, immigrants, Muslims, women, you name it, get as much or more than the middle aged white guys.

Nope, you, and the system will need much more imagination than that.

It seems I didn't convey my points well enough...but again it's this simple; if faced between a collapsing, black-hole of deflationary badness, and using electronic digits to prevent worse and get things going again 'in the right direction' it is my view that the Fed would do exactly that.

To your points:

More debt would need to be issued? So what? More debt is no big deal. The government issues the debt and the Fed monetizes it. That's nothing different than has been happening for 7 years without anybody in power making a any stink at all. So I'm saying even more could happen. Easy. Because it already has.

"Truly staggering"? Care to quantify that? More than the nearly $4 trillion already printed? Who's to say that the Fed's balance sheet could not expand to $10 trillion? Or $100 trillion? It's not like any actual limits exist. I got in arguments with people who insisted that the Fed could not take its balance sheet much beyond $1 trillion "because bad things would happen." Well, they haven't. That's the lesson so far.

Yep. that would be the point...pay down the debts that would otherwise enter default and go to zero. Faced between a ruined balance sheet and one paid off, are you seriously proposing that banks would prefer ruin? Time for you to go talk to a banker or two...

A political nightmare? Possibly, but again when an emergency is afoot, all sorts of previously unthinkable things suddenly become quite doable. And I seriously doubt that the people would put up any stink at all over a massive free handout. It would be among the most popular of all government programs in a very long time.

I try to imagine myself trying to warn my family and friends that the government's big free handout of money is a VERY bad sign, and trying to convince them to pay down all their debt and spend everything they have left on tangible assets they're going to need to survive. I imagine those that have paid taxes getting a refund on all their federal taxes from the last year or two, and those who didn't pay taxes getting a check for $500. They're going to think I've totally lost my mind at that point because I've equated that program with the beginning of the end of the world as we know it.

BTW, at that point, I would probably either retire early, sell my house in the big city and head for the hinterlands, or buy the property up there and be ready to go on a moment's notice. Of the various possible outcomes, I see this one as likely as any other.

We also goosed the economy with the payroll tax holiday, which was in effect from 2011 - 2012. It reduced the employee contribution toward social security taxes from 6.2% to 4.2%. When the payroll tax holiday expired on 12/31/13, it made a noticeable difference in take home pay for lower paid employees.

Just to get into somebody else's dogfight for no good reason, I'm going with EFarmer ,backing Fitts over Hudes as she's the "devil" I know best, though ignoring Arthur's McDonald's 5 star rating of Hudes is not for the the faint hearted.

As a minimillist Roman Catholic, my opinion of the Vatican's prowess in any sphere these days is low to lower. OTOH my opinion of Pope Francis is very high, and I have been concerned almost since he appeared that he is going to assassinated sooner or later. He must have stepped on the toes of everybody who is easily upset by decency in high places by now.

For totally different reasons, I would have Hillary Clinton's security tightened, as it could be in many people's interest to give Donald a helping hand. Of course I fully realize that Hillary herself is probably more than capable of mixing it with the darkest of devils.

It would still have to be issued first as Bonds which are just more debt

The amount needed to goose the economy would be truly staggering and the banks would never permit it because

A very significant amount of it would be used to pay down existing debt, transferring personal debt to the state, usurping the privileges of the financial sector.

The distribution would be a political nightmare. If you want a real shitfight, just try suggesting that the "worthless" unemployed, welfare queens, blacks, immigrants, Muslims, women, you name it, get as much or more than the middle aged white guys.

Nope, you, and the system will need much more imagination than that.

It seems I didn't convey my points well enough...but again it's this simple; if faced between a collapsing, black-hole of deflationary badness, and using electronic digits to prevent worse and get things going again 'in the right direction' it is my view that the Fed would do exactly that.

To your points:

More debt would need to be issued? So what? More debt is no big deal. The government issues the debt and the Fed monetizes it. That's nothing different than has been happening for 7 years without anybody in power making a any stink at all. So I'm saying even more could happen. Easy. Because it already has.

"Truly staggering"? Care to quantify that? More than the nearly $4 trillion already printed? Who's to say that the Fed's balance sheet could not expand to $10 trillion? Or $100 trillion? It's not like any actual limits exist. I got in arguments with people who insisted that the Fed could not take its balance sheet much beyond $1 trillion "because bad things would happen." Well, they haven't. That's the lesson so far.

Yep. that would be the point...pay down the debts that would otherwise enter default and go to zero. Faced between a ruined balance sheet and one paid off, are you seriously proposing that banks would prefer ruin? Time for you to go talk to a banker or two...

A political nightmare? Possibly, but again when an emergency is afoot, all sorts of previously unthinkable things suddenly become quite doable. And I seriously doubt that the people would put up any stink at all over a massive free handout. It would be among the most popular of all government programs in a very long time.

Point 3 the bankers win again! Let's modify that: downsize banking by forcing receivership and writing off much debt.

I think the words that immediately and reflexively came out of my mouth when I scrolled through the derivatives were, "Oh, f***!" I was aware of these numbers for a while, but this REALLY puts it into perspective.

Hey all. Its been a while since ive posted on here. Things have been good in the US for a few years now. Good being a relative term. Of course, the SPX hit 2134 and bonds continue in boom mode. The rally in equities has finally stalled. Some real technical damage took place with SPX hitting 1812 before reversing. Thats a solid 15 percent drop. We hit 1900 today so lets see what the market does now.

Crude oil has utterly collapsed. Now we are seeing the much needed bounce. Hopefully it can stabilize in the 30s.

As for the US economic data, it is mixed at this time. Leading economic indicators are still posting postive numbers indicating expansion. Employment data is still positive. US auto sales are at 17 million. Lets see what 2016 brings. Single family home construction is still weak and never bounced. Multi units are positive. US commercial real estate is now priced 15 percent higher than the 2007 peak. ATA trucking index is positive. The recent philly and NY fed surveys are weak.

Just because the stock market is correcting doesnt mean the economy is going to go in the gutter. Perhaps the market going down can slow corp and consumer spending to a point. I am waiting until the summer before I make any recession predicitons.

As for the US economic data, it is mixed at this time. Leading economic indicators are still posting positive numbers indicating expansion. Employment data is still positive. US auto sales are at 17 million...

It seems that JD and the US President and many others believe that auto sales are a shining sign of a healthy economy. But if you look under the hood, you'll see that the 2015 increase in auto sales is due to a bubble in consumer borrowing for automobile purchases. The bubble in auto loans was created using a model very similar to the subprime housing loan fiasco. Quoting the Q1 2015 numbers from Zero Hedge & Experian:

Quote:

... auto loan-backed issuance accounts for half of the [ABS] market and a quarter of auto ABS is backed by loans to subprime borrowers.

The push to feed the securitization machine begets more competition among lenders for a shrinking pool of creditworthy borrowers and when that pool dries up, well, the definition of "creditworthy" must necessarily be relaxed, otherwise the securitization machine stalls for lack of fuel.

Average loan term for new cars is now 67 months — a record.Average loan term for used cars is now 62 months — a record.Loans with terms from 74 to 84 months made up 30% of all new vehicle financing — a record.Loans with terms from 74 to 84 months made up 16% of all used vehicle financing — a record.The average amount financed for a new vehicle was $28,711 — a record.The average payment for new vehicles was $488 — a record.The percentage of all new vehicles financed accounted for by leases was 31.46% — a record.

The 2015 bump in auto sales that resulted from lowered lending standards represents, at best, a drain on future demand and, at worst, another serious credit bubble about to pop. Even the regulators are worried:

“Over the six months through September, more than $110 billion of auto loans have been originated to borrowers with credit scores below 660, the bottom cutoff for having a credit score generally considered good,” the report reads. “Of that sum, about $70 billion went to borrowers with credit scores below 620, scored that are considered bad.”

Regulators are taking notice too. In a speech last month, Comptroller of the Currency Thomas Curry said that what was happening in auto lending, “reminds me of what happened in mortgage-backed securities in the run up to the crisis”

Although the other indicators may (or may not) reflect a healthy economy, the increase in auto sales is a sign of economic dysfunction, not health.

Correct me if I'm wrong, but aren't derivatives just another form of debt expansion? Seems to me that without the derivatives market, continued debt expansion would have become problematic a while back...perhaps a decade or more. Just looking at the size of the derivative market...the left brain envisions a paper masking over of the exponential debt-credit hockey stick...that has been going on for a good long while.

So I've been reading and following fund managers such as Raoul Pal and it seems like there's a high probability of further deflation causing stocks/commodities to fall in price, while bonds/dollar go up and rates fall. So where does that leave gold? If the dollar gets stronger is there more room to fall? It looks like on the DX the next target to the upside is 120. That would be a 20% rally from the previous high at 100. If gold and DX were on a -1 correlation (historically they are not), that would put it at 836.8 in the futures. That would be around the previous resistance from the 1980 rally. In the 1930s gold did rally even in the deflationary cycle and I'm wondering if globally rates are nominally negative, who wouldn't want gold/silver? I currently have around 15% in physical precious metals (about 50% gold, 50% silver), another 10% in mining stocks, and 66% in cash (I missed the bond rally and don't plan on buying here). Is there an allocation such as Marc Faber's 25/25/25/25 metals, cash, property, equities that are optimal in this environment? I'm curious to hear other people's opinion who are anticipating this large deleveraging cycle.